Enter the dragon - but beware the elephant

ByDavid R. FrancisFebruary 3, 2005

Four decades ago, China and India fought a border war. Now, the dragon and the elephant have begun a dance - partly competitive, partly cooperative - that is starting to shake the world economic order.

In the West, the widespread assumption is that China will compete in manufactured goods while India will provide call centers and other information technology services. But that's too simplistic.

The two awakening economies will be integrated into the global economy industry by industry, says Diana Farrell, director of the McKinsey Global Institute, a New York think tank. China's strengths in electronic parts and products, for instance, won't keep it from developing a vibrant service sector, just as India's know-how in software, engineering, and medicine doesn't preclude

More important, competition between these two rivals is likely to supercharge the growth that already has economists shaking their heads in wonder.

For example, India's economy grew at a real 8.5 percent in the year ended last March - beating even China's 8.1 percent average growth after inflation between 1995 and 2002. But last year, China came back on top, posting a sizzling 9.5 percent growth rate.

Just back from a visit to India, economist Ritu Kochhar detected a "strong ... competitive spirit" among manufacturers dealing with Chinese firms. Their exports to China, though relatively small, have grown "very rapidly."

Now, a few Chinese and Indian firms are investing on each other's turf, notes Tarun Khanna, a Harvard Business School professor. A Chinese telecom equipmentmaker has put money into India. An Indian outsourcing firm has invested in China. When Mr. Khanna visits his homeland, he sees many more Chinese on the streets of New Delhi and Indian cities to the south than he did five years ago. He predicts an acceleration in such investments.

China is the Asian giant that most wows the world. Its gross domestic product - its output of goods and services - will surpass that of the United States in the next 10 years, predicts the Employment Policy Foundation, a Washington think tank. "It will be the first time since World War I that the [US] has not had the world's largest GDP," it says in a recent analysis.

But recently India, the world's second most populous nation, has stepped up its own growth rate, raising eyebrows abroad, and catching Wall Street's attention. Over the last two years, foreigners have added $18 billion in Indian paper assets to their investment portfolios, says Mr. Kochhar, an analyst in New York with Bear, Stearns & Co., an investment banking firm.

Another $4 billion to $5 billion was invested in plant and equipment in India last year. That's small change compared with the $60 billion China got. Nonetheless, India is coming on strong. Its industrial and service sectors should grow 8 percent, reckons Kochhar. Continued modest economic reforms have begun to spur growth.

Ultimately, the rise of these two nations means more competition for companies in the US and Europe.

"It could make life uncomfortable for some companies," Khanna says. But "that will end up benefiting consumers." And not just in the West.

India and China now have sizable middle classes and consumer markets. China's rapid growth has meant a large number of people make more than $20,000 a year. China already has the world's largest cellphone market. Its auto market surpasses Germany's.

India's per capita GDP is only half that of China, says Kochhar. Yet its middle class, depending on the definition, numbers 200 million to 250 million people.

These two giants are not only increasingly competitive, they're a study in contrasting routes to prosperity.

China's government nurtures and directs economic activity more than India's. With a national savings rate of nearly 40 percent, it was able to invest enormous sums in infrastructure - roads, bridges, ports, power plants, and so on. Such facilities, combined with low-cost labor, attracted more than 8 percent of the world's direct investment. That investment has built factories and allowed China to acquire know-how and the latest technologies.

India, by contrast, makes use of an educated upper class, spawning a growing number of entrepreneurs. Since the mid-1980s, notes Khanna, its government has become less interventionist. Even the United Progressive Alliance, which includes two communist parties and took power after elections last year, has cautiously continued moves to encourage free enterprise, says Kochhar. Corporate taxes have been cut. The top rate for tariffs reduced in some areas. Restrictive rules on foreign investment are being relaxed. A budget later this month may signal further reforms.

Who will win in the long run? India has a larger population of young workers. But most analysts pick China, which has a head start in what is quickly becoming the world's most economically vibrant region.

But nothing is ever a sure thing in business. Remember, 20 years ago Japan looked like the world-beater.